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1 Adeng Pustikaningsih, M.Si. Dosen Jurusan Pendidikan Akuntansi Fakultas Ekonomi Universitas Negeri Yogyakarta CP: adengpustikaningsih@uny.ac.id 7-1

2 7-2

3 PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield

4 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-4

5 CASH What is Cash? A financial asset also a financial instrument. Financial Instrument - Any contract that gives rise to a financial asset of one entity and a financial liability or equity interest of another entity. ILLUSTRATION 7-1 Types of Assets 7-5 LO 1

6 CASH What is Cash? Most liquid asset. Standard medium of exchange. Basis for measuring and accounting for all other items. Current asset. Examples: Coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier s checks, personal checks, bank drafts and savings accounts. 7-6 LO 1

7 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-7

8 CASH Reporting Cash Cash Equivalents Short-term, highly liquid investments that are both a) readily convertible to cash, and b) so near their maturity that they present insignificant risk of changes in value. Examples: Treasury bills, commercial paper, and money market funds. 7-8 LO 2

9 Reporting Cash Restricted Cash Companies segregate restricted cash from regular cash. Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. ILLUSTRATION 7-2 Disclosure of Restricted Cash 7-9 LO 2

10 Reporting Cash Bank Overdrafts Company writes a check for more than the amount in its cash account. Generally reported as a current liability. Offset against other cash accounts only when accounts are with the same bank LO 2

11 Summary of Cash-Related Items ILLUSTRATION LO 2

12 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-12

13 ACCOUNTS RECEIVABLE Receivables - Claims held against customers and others for money, goods, or services. Oral promises of the purchaser to pay for goods and services sold. Accounts Receivable Written promises to pay a certain sum of money on a specified future date. Notes Receivable 7-13 LO 3

14 ACCOUNTS RECEIVABLE Non-Trade Receivables 1. Advances to officers and employees. 2. Advances to subsidiaries. 3. Deposits paid to cover potential damages or losses. 4. Deposits paid as a guarantee of performance or payment. 5. Dividends and interest receivable. 6. Claims against: Insurance companies for casualties sustained; defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods; customers for returnable items (crates, containers, etc.) LO 3

15 Non-Trade Receivables ILLUSTRATION 7-4 Receivables Statement of Financial Position Sheet Presentations 7-15 LO 3

16 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-16

17 Recognition of Accounts Receivable Trade Discounts Use to: Avoid frequent changes in catalogs. Alter prices for different quantities purchased. Hide the true invoice price from competitors. 10 % Discount for new Retail Store Customers 7-17 LO 4

18 Recognition of Accounts Receivable Cash Discounts (Sales Discounts) Offered to induce prompt payment. Terms such as 2/10, n/30, 2/10, E.O.M., or net 30, E.O.M. Gross Method vs. Net Method. Payment terms are 2/10, n/ LO 4

19 Cash Discounts (Sales Discounts) ILLUSTRATION 7-5 Entries under Gross and Net Methods 7-19 LO 4

20 Recognition of Accounts Receivable Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of 2,000 with terms of 2/10, n/60. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. June 3 Accounts Receivable 2,000 Sales Revenue 2,000 June 12 Cash ( 2,000 x 98%) 1,960 Sales Discounts 40 Accounts Receivable 2, LO 4

21 Recognition of Accounts Receivable Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of 2,000 with terms of 2/10, n/60. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method. June 3 Accounts Receivable 1,960 Sales Revenue 1,960 June 12 Cash ( 2,000 x 98%) 1,960 Accounts Receivable 1, LO 4

22 Recognition of Accounts Receivable Illustration: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of 2,000 with terms of 2/10, n/60, f.o.b. shipping point. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method, and and Arquette did not remit payment until July 29. June 3 Accounts Receivable 1,960 Sales Revenue 1,960 June 12 Cash 2,000 Accounts Receivable 1,960 Sales Discounts Forfeited LO 4

23 Recognition of Accounts Receivable Non-Recognition of Interest Element A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period LO 4

24 ACCOUNTS RECEIVABLE How are these accounts presented on the Statement of Financial Position? Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End LO 4

25 ACCOUNTS RECEIVABLE Current Assets: ABC Corporation Statement of Financial Position (partial) Inventory $ 812 Prepaid expense 40 Accounts receivable 500 Less: Allowance for doubtful accounts (25) 475 Cash 330 Total current assets 1, LO 4

26 ACCOUNTS RECEIVABLE Current Assets: ABC Corporation Statement of Financial Position (partial) Inventory $ 812 Prepaid expense 40 Accounts receivable, net of $25 allowance 475 Cash 330 Total current assets 1, LO 4

27 ACCOUNTS RECEIVABLE Journal entry for credit sale of $100? Accounts Receivable 100 Sales Revenue 100 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. End End LO 4

28 ACCOUNTS RECEIVABLE Journal entry for credit sale of $100? Accounts Receivable 100 Sales Revenue 100 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale 100 End End LO 4

29 ACCOUNTS RECEIVABLE Collected $333 on account? Cash 333 Accounts Receivable 333 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale 100 End End LO 4

30 ACCOUNTS RECEIVABLE Collected $333 on account? Cash 333 Accounts Receivable 333 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale Coll. End End LO 4

31 ACCOUNTS RECEIVABLE Adjustment of $15 for estimated bad debts? Bad Debt Expense 15 Allowance for Doubtful Accounts 15 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale Coll. End End LO 4

32 ACCOUNTS RECEIVABLE Adjustment of $15 for estimated bad debts? Bad Debt Expense 15 Allowance for Doubtful Accounts 15 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale Coll. 15 Est. End End LO 4

33 ACCOUNTS RECEIVABLE Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts Receivable 10 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale Coll. 15 Est. End End LO 4

34 ACCOUNTS RECEIVABLE Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts Receivable 10 Accounts Receivable Allowance for Doubtful Accounts Beg Beg. Sale Coll. 15 Est. 10 W/O W/O 10 End End LO 4

35 ACCOUNTS RECEIVABLE Current Assets: ABC Corporation Statement of Financial Position (partial) Inventory $ 812 Prepaid expense 40 Accounts receivable, net of $30 allowance 227 Cash 330 Total current assets 1, LO 4

36 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-36

37 ACCOUNTS RECEIVABLE Valuation of Accounts Receivable Reporting of receivables involves 1) classification and 2) valuation on the statement of financial position. Classification involves determining the length of time each receivable will be outstanding. Value and report short-term receivables at cash realizable value LO 5

38 Valuation of Accounts Receivable Uncollectible Accounts Receivable Record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense). Normal and necessary risk of doing business on credit. Two methods to account for uncollectible accounts: 1) Direct write-off method 2) Allowance method 7-38 LO 5

39 Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically deficient: No matching. Receivable not stated at cash realizable value. Not appropriate when amount uncollectible is material. Allowance Method Losses are estimated: Percentage-of-sales. Percentage-of-receivables. IFRS requires when bad debts are material in amount LO 5

40 Allowance Method ILLUSTRATION 7-7 Comparison of Bases for Estimating Uncollectibles The percentage-of-sales basis results in a better matching of expenses with revenues The percentage-of-receivables basis produces the better estimate of cash realizable value 7-40 LO 5

41 Allowance Method Percentage-of-Sales Approach Percentage based upon past experience and anticipate credit policy. Achieves better matching of cost and revenues. Any balance in Allowance for Doubtful Accounts is ignored. Method frequently referred to as the income statement approach LO 5

42 Percentage-of-Sales Approach Illustration: Gonzalez Company estimates that about 1% of net credit sales will become uncollectible. If net credit sales are R$800,000 for the year, it records bad debt expense as follows. Bad Debt Expense (1% x R$800,000) 8,000 Allowance for Doubtful Accounts 8,000 ILLUSTRATION LO 5

43 Allowance Method Percentage-of-Receivables Approach Not matching. Estimate of the receivables realizable value. Companies may apply this method using one composite rate, or an aging schedule using different rates LO 5

44 Percentage-of-Receivables Approach ILLUSTRATION 7-9 Accounts Receivable Aging Schedule What entry would Wilson make assuming that the allowance account had a zero balance? Bad Debt Expense 37,650 Allowance for Doubtful Accounts 37, LO 5

45 Percentage-of-Receivables Approach ILLUSTRATION 7-9 Accounts Receivable Aging Schedule What entry would Wilson make assuming the allowance account had a credit balance of 800 before adjustment? Bad Debt Expense ( 37, ) 36,850 Allowance for Doubtful Accounts 36, LO 5

46 Allowance Method Illustration: Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable LO 5

47 Allowance Method Illustration: Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 1% of net sales. Bad Debt Expense 7,500 Allowance for Doubtful Accounts 7,500 ( 800,000 50,000) x 1% = 7, LO 5

48 Allowance Method Illustration: Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Bad Debt Expense 6,000 Allowance for Doubtful Accounts 6,000 ( 160,000 x 5%) 2,000) = 6, LO 5

49 Write-Off of Uncollectible Accounts Illustration: The financial vice president of Brown Furniture authorizes a write-off of the 1,000 balance owed by Randall Co. on March 1. The entry to record the write-off is: Allowance for Doubtful Accounts 1,000 Accounts Receivable 1,000 Assume that on July 1, Randall Co. pays the 1,000 amount that Brown had written off on March 1. These are the entries: Accounts Receivable 1,000 Allowance for Doubtful Accounts 1,000 Cash 1,000 Accounts Receivable 1, LO 5

50 Impairment Evaluation Process Companies assess their receivables for impairment each reporting period. Possible loss events are: 1. Significant financial problems of the customer. 2. Payment defaults. 3. Renegotiation of terms of the receivable due to financial difficulty of the customer. 4. Decrease in estimated future cash flows from a group of receivables since initial recognition, although the decrease cannot yet be identified with individual assets in the group LO 5

51 Impairment Evaluation Process A receivable is considered impaired when a loss event indicates a negative impact on the estimated future cash flows to be received from the customer. The IASB requires that the impairment assessment should be performed as follows. 1. Receivables that are individually significant should be considered for impairment separately. 2. Any receivable individually assessed that is not considered impaired should be included with a group of assets with similar credit-risk characteristics and collectively assessed for impairment. 3. Any receivables not individually assessed should be collectively assessed for impairment LO 5

52 Impairment Evaluation Process Illustration: Hector Company has the following receivables classified into individually significant and all other receivables. Hector determines that Yaan s receivable is impaired by 15,000, and Blanchard s receivable is totally impaired. Both Randon s and Fernando s receivables are not considered impaired. Hector also determines that a composite rate of 2% is appropriate to measure impairment on all other receivables LO 5

53 Impairment Evaluation Process The total impairment is computed as follows. ILLUSTRATION LO 5

54 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-54

55 NOTES RECEIVABLE Supported by a formal promissory note. A negotiable instrument. Maker signs in favor of a Payee. Interest-bearing (has a stated rate of interest) OR Zero-interest-bearing (interest included in face amount) LO 6

56 NOTES RECEIVABLE Generally originate from: Customers who need to extend payment period of an outstanding receivable. High-risk or new customers. Loans to employees and subsidiaries. Sales of property, plant, and equipment. Lending transactions (the majority of notes) LO 6

57 Recognition of Notes Receivable Short-Term Record at Face Value, less allowance Interest Rates Stated rate = Market rate Stated rate > Market rate Stated rate < Market rate Long-Term Record at Present Value of cash expected to be collected Note Issued at Face Value Premium Discount 7-57 LO 6

58 Note Issued at Face Value Illustration: Bigelow Corp. lends Scandinavian Imports 10,000 in exchange for a 10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note? i = 10% 10,000 Principal PV-OA 1,000 1,000 1,000 Interest n = 3 ILLUSTRATION 7-11 Time Diagram for Note Issued at Face Value 4 LO 6

59 Note Issued at Face Value PV of Interest 1,000 x = 2,487 Interest Received Factor Present Value 7-59 LO 6

60 Note Issued at Face Value PV of Principal 10,000 x = 7,513 Principal Factor Present Value 7-60 LO 6

61 Note Issued at Face Value Summary Present value of interest 2,487 Present value of principal 7,513 Note current market value 10,000 Journal Entries Jan. yr. 1 Dec. yr. 1 Notes Receivable 10,000 Cash 10,000 Cash 1,000 Interest Revenue 1, LO 6

62 Zero-Interest-Bearing Notes Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note? i = 9% $10,000 Principal PV-0A $0 $0 $0 Interest ILLUSTRATION 7-13 Time Diagram for Zero- Interest-Bearing Note n = LO 6

63 Zero-Interest-Bearing Notes PV of Principal $10,000 x = $7, Principal Factor Present Value 7-63 LO 6

64 Zero-Interest-Bearing Notes ILLUSTRATION 7-14 Discount Amortization Schedule Effective-Interest Method 7-64 LO 6

65 Zero-Interest-Bearing Notes ILLUSTRATION 7-14 Discount Amortization Schedule Effective- Interest Method Prepare the journal entry to record the receipt of the note. Notes Receivable 7, Cash 7, LO 6

66 Zero-Interest-Bearing Notes ILLUSTRATION 7-14 Discount Amortization Schedule Effective- Interest Method Record interest revenue at the end of the first year. Notes Receivable Interest Revenue ($7, x 9%) LO 6

67 Interest-Bearing Notes Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, 10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. Prepare the journal entry to record the receipt of the note? i = 12% 10,000 Principal PV-0A 1,000 1,000 1,000 Interest n = LO 6

68 Interest-Bearing Notes PV of Interest 1,000 x = 2,402 Interest Received Factor Present Value 7-68 LO 6

69 Interest-Bearing Notes PV of Principal 10,000 x = 7,118 Principal Factor Present Value 7-69 LO 6

70 Interest-Bearing Notes Illustration: Record the receipt of the note? ILLUSTRATION 7-16 Computation of Present Value Effective Rate Different from Stated Rate Notes Receivable 9,520 Cash 9, LO 6

71 Interest-Bearing Notes ILLUSTRATION 7-17 Discount Amortization Schedule Effective-Interest Method 7-71 LO 6

72 Interest-Bearing Notes ILLUSTRATION 7-17 Discount Amortization Schedule Effective-Interest Method Record interest revenue at the end of the first year. Cash 1,000 Notes Receivable 142 Interest Revenue 1, LO 6

73 Notes Receivable Notes Received for Property, Goods, or Services In a bargained transaction entered into at arm s length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or 2. Stated interest rate is unreasonable, or 3. Face amount of the note is materially different from the current cash sales price or from the current market value of the debt instrument LO 6

74 Notes for Property, Goods, or Services Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of 35,247 and no stated interest rate. The land originally cost Oasis 14,000. At the date of sale the land had a fair market value of 20,000. Oasis uses the fair market value of the land, 20,000, as the present value of the note. Oasis therefore records the sale as: Notes Receivable 20,000 Land 14,000 Gain on Sale of Land ( 20,000-14,000) 6, LO 6

75 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-75

76 Valuation of Notes Receivable Short-Term reporting parallels that for trade accounts receivable. Long-Term Value may change over time as a discount or premium is amortized. Impairment Tests often done on an individual assessment basis. Losses measured as the difference between the carrying value of the receivable and the present value of the estimated future cash flows discounted at the original effective-interest rate LO 7

77 Valuation of Notes Receivable Illustration: Tesco Inc. has a note receivable with a carrying amount of 200,000. The debtor, Morganese Company, has indicated that it is experiencing financial difficulty. Tesco decides that Morganese s note receivable is therefore impaired. Tesco computes the present value of the future cash flows discounted at its original effective-interest rate to be 175,000. The computation of the loss on impairment is as follows LO 7

78 Valuation of Notes Receivable The computation of the loss on impairment is as follows. The entry to record the impairment loss is as follows. Bad Debt Expense 25,000 Allowance for Doubtful Accounts 25, LO 7

79 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-79

80 SPECIAL ISSUES Fair Value Option Companies have the option to record fair value in their accounts for most financial assets and liabilities, including receivables. If companies choose the fair value option Receivables are recorded at fair value. Unrealized holding gains or losses reported as part of net income. Company reports the receivable at fair value each reporting date LO 8

81 SPECIAL ISSUES Fair Value Option Companies may elect to use the fair value option at the time the receivable is originally recognized or when some event triggers a new basis of accounting. Must continue to use fair value measurement for that receivable until the company no longer owns this receivable. If not elected at date of recognition, company may not use the fair value option on that specific receivable LO 8

82 Recording Fair Value Option Illustration: Escobar Company has notes receivable that have a fair value of R$810,000 and a carrying amount of R$620,000. Escobar decides on December 31, of the current year, to use the fair value option for these receivables. This is the first valuation of these recently acquired receivables. At December 31, Escobar makes an adjusting entry to record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows. Notes Receivable 190,000 Unrealized Holding Gain or Loss Income 190, LO 8

83 SPECIAL ISSUES Derecognition of Receivables Transfer (e.g., sell) receivables to another company for cash. Reasons: Accelerate the receipt of cash. Competition. Sell receivables because money is tight. Billing / collection are time-consuming and costly. Transfer accomplished by: 1. Secured borrowing 2. Sale of receivables 7-83 LO 8

84 Derecognition of Receivables Secured Borrowing Using receivables as collateral in a borrowing transaction. Illustration: On March 1, 2015, Meng Mills, Inc. provides (assigns) NT$700,000 of its accounts receivable to Sino Bank as collateral for a NT$500,000 note. Meng Mills continues to collect the accounts receivable; the account debtors are not notified of the arrangement. Sino Bank assesses a finance charge of 1 percent of the accounts receivable and interest on the note of 12 percent. Meng Mills makes monthly payments to the bank for all cash it collects on the receivables LO 8

85 Secured Borrowing ILLUSTRATION 7-18 Entries for Transfer of Receivables Secured Borrowing 7-85 LO 8

86 7-86 ILLUSTRATION 7-18 Entries for Transfer of Receivables Secured Borrowing LO 8

87 Secured Borrowing Illustration: On April 1, 2015, Prince Company assigns $500,000 of its accounts receivable to the Hibernia Bank as collateral for a $300,000 loan due July 1, The assignment agreement calls for Prince Company to continue to collect the receivables. Hibernia Bank assesses a finance charge of 2% of the accounts receivable, and interest on the loan is 10% (a realistic rate of interest for a note of this type). Instructions: a) Prepare the April 1, 2015, journal entry for Prince Company. b) Prepare the journal entry for Prince s collection of $350,000 of the accounts receivable during the period from April 1, 2015, through June 30, c) On July 1, 2015, Prince paid Hibernia all that was due from the loan it secured on April 1, LO 8

88 Secured Borrowing Instructions: a) Prepare the April 1, 2015, journal entry for Prince Company. b) Prepare the journal entry for Prince s collection of $350,000. c) On July 1, 2015, Prince paid Hibernia all that was due from the loan it secured on April 1, a) b) c) Cash 290,000 Finance Charge ($500,000 x 2%) 10,000 Notes Payable 300,000 Cash 350,000 Accounts Receivable 350,000 Notes Payable 300,000 Interest Expense (10% x $300,000 x 3/12) 7,500 Cash 307,500 LO 8

89 Sales of Receivables Factors are finance companies or banks that buy receivables from businesses for a fee. ILLUSTRATION 7-19 Basic Procedures in Factoring 7-89

90 Sales of Receivables Sale without Guarantee Purchaser assumes risk of collection. Transfer is outright sale of receivable. Seller records loss on sale. Seller uses a Due from Factor (receivable) account to cover discounts, returns, and allowances LO 8

91 Sale without Guarantee Illustration: Crest Textiles, Inc. factors 500,000 of accounts receivable with Commercial Factors, Inc., on a non-guarantee basis. Commercial Factors assesses a finance charge of 3 percent of the amount of accounts receivable and retains an amount equal to 5 percent of the accounts receivable (for probable adjustments). Crest Textiles and Commercial Factors make the following journal entries for the receivables transferred without guarantee. ILLUSTRATION 7-20 Entries for Sale of Receivables without Guarantee 7-91 LO 8

92 Sales of Receivables Sale with Guarantee Seller guarantees payment to purchaser. Transfer is considered a borrowing sometimes referred to as a failed sale. Assume Crest Textiles sold the receivables on a with guarantee basis. ILLUSTRATION 7-21 Sale with Guarantee 7-92 LO 8

93 Summary of Transfers ILLUSTRATION 7-22 Accounting for Transfers of Receivables 7-93 LO 8

94 7 Cash and Receivables LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify items considered cash. 2. Indicate how to report cash and related items. 3. Define receivables and identify the different types of receivables. 4. Explain accounting issues related to recognition of accounts receivable. 5. Explain accounting issues related to valuation of accounts receivable. 6. Explain accounting issues related to recognition of notes receivable. 7. Explain accounting issues related to valuation of notes receivable. 8. Understand special topics related to receivables. 9. Describe how to report and analyze receivables. 7-94

95 Presentation and Analysis 7-95 General rules in classifying receivables are: 1. Segregate and report carrying amounts of different categories of receivables. 2. Indicate receivables classified as current and non-current in the statement of financial position. 3. Appropriately offset the valuation accounts for receivables that are impaired, including a discussion of individual and collectively determined impairments. 4. Disclose the fair value of receivables in such a way that permits it to be compared with its carrying amount. 5. Disclose information to assess the credit risk inherent in the receivables. 6. Disclose any receivables pledged as collateral. 7. Disclose all significant concentrations of credit risk arising from receivables. LO 9

96 Presentation and Analysis Analysis of Receivables ILLUSTRATION 7-24 Computation of Accounts Receivable Turnover This Ratio used to: Assess the liquidity of the receivables. Measure the number of times, on average, a company collects receivables during the period LO 9

97 GLOBAL ACCOUNTING INSIGHTS CASH AND RECEIVABLES IFRS and U.S. GAAP are very similar in accounting for cash and receivables. For example, the definition of cash and cash equivalents is similar, and both IFRS and U.S. GAAP have a fair value option. In the wake of the international credit crisis, the Boards are working together to improve the accounting for loan impairments. 7-97

98 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S. GAAP and IFRS related to cash and receivables. Similarities The accounting and reporting related to cash is essentially the same under both U.S. GAAP and IFRS. In addition, the definition used for cash equivalents is the same. Cash and receivables are generally reported in the current assets section of the balance sheet under U.S. GAAP, similar to IFRS. U.S. GAAP requires that loans and receivables be accounted for at amortized cost, adjusted for allowances for doubtful accounts, similar to IFRS. 7-98

99 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences Under U.S. GAAP, cash and receivables are reported in order of liquidity. Under IFRS, companies may report cash and receivables as the last items in current assets. U.S. GAAP has explicit guidance concerning how receivables with different characteristics should be reported separately. There is no IFRS that mandates this segregation. The fair value option is similar under U.S. GAAP and IFRS but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered. 7-99

100 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences Under U.S. GAAP, overdrafts are reported as liabilities. Under IFRS, bank overdrafts are generally reported as cash if such overdrafts are repayable upon demand and are an integral part of a company s cash management (offsetting arrangements against other accounts at the same bank). U.S. GAAP and IFRS differ in the criteria used to account for transfers of receivables. U.S. GAAP uses loss of control as the primary criterion. IFRS is a combination of an approach focused on risks and rewards and loss of control. In addition, U.S. GAAP does not permit partial transfers; IFRS generally does

101 GLOBAL ACCOUNTING INSIGHTS About the Numbers In the accounting for loans and receivables, IFRS permits the reversal of impairment losses, with the reversal limited to the asset s amortized cost before the impairment. To illustrate, Zirbel Company has a loan receivable with a carrying value of $10,000 at December 31, On January 2, 2015, the borrower declares bankruptcy, and Zirbel estimates that it will collect only onehalf of the loan balance. Zirbel makes the following entry to record the impairment. Impairment Loss 5,000 Loan Receivable 5,

102 GLOBAL ACCOUNTING INSIGHTS About the Numbers On January 10, 2016, Zirbel learns that the customer has emerged from bankruptcy. Zirbel now estimates that all but $1,000 will be repaid on the loan. Under IFRS, Zirbel records this reversal as follows. Loan Receivable 4,000 Recovery of Impairment Loss 4,000 Zirbel reports the recovery in 2016 income. Under U.S. GAAP, reversal of an impairment is not permitted. Rather, the balance on the loan after the impairment becomes the new basis for the loan

103 GLOBAL ACCOUNTING INSIGHTS On the Horizon Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. The fair value option for recording financial instruments such as receivables is an important step in moving closer to fair value recording. Finally, the IASB is working on a new impairment model, which will be more forward-looking when evaluating financial instruments for impairment. The FASB is working on a similar impairment model. The final standards adopted, however, may not be fully converged in terms of the implementation details

104 APPENDIX 7A CASH CONTROLS Management faces two problems in accounting for cash transactions: 1. Establish proper controls to prevent any unauthorized transactions by officers or employees. 2. Provide information necessary to properly manage cash on hand and cash transactions LO 10 Explain common techniques employed to control cash.

105 USING BANK ACCOUNTS To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts. General checking account Collection float Lockbox accounts Imprest bank accounts LO 10

106 THE IMPREST PETTY CASH SYSTEM Used to pay small amounts for miscellaneous expenses. Steps: 1. Record the transfer of $300 to petty cash: Petty Cash 300 Cash Petty cash custodian obtains signed receipts from each individual to whom he or she pays cash LO 10

107 THE IMPREST PETTY CASH SYSTEM Steps: 3. Custodian receives a company check to replenish the fund. Supplies Expense 42 Postage Expense 53 Miscellaneous Expense 76 Cash Over and Short 2 Cash LO 10

108 THE IMPREST PETTY CASH SYSTEM Steps: 4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows. Cash 50 Petty cash LO 10

109 PHYSICAL PROTECTION OF CASH BALANCES Company should Minimize the cash on hand. Only have on hand petty cash and current day s receipts. Keep funds in a vault, safe, or locked cash drawer. Transmit each day s receipts to the bank as soon as practicable. Periodically prove the balance shown in the general ledger LO 10

110 RECONCILIATION OF BANK BALANCES Schedule explaining any differences between the bank s and the company s records of cash. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Bank charges Time Lags 4. Bank credits. 5. Bank or depositor errors LO 10

111 RECONCILIATION OF BANK BALANCES ILLUSTRATION 7A-1 Bank Reconciliation Form and Content LO 10

112 RECONCILIATION OF BANK BALANCES To illustrate, Nugget Mining Company s books show a cash balance at the Melbourne Bank on November 30, 2015, of $20,502. The bank statement covering the month of November shows an ending balance of $22,190. An examination of Nugget s accounting records and November bank statement identified the following reconciling items. 1. A deposit of $3,680 that Nugget mailed November 30 does not appear on the bank statement. 2. Checks written in November but not charged to the November bank statement are: Check #7327 $ 150 #7348 4,820 # Nugget has not yet recorded the $600 of interest collected by the bank November 20 on Sequoia Co. bonds held by the bank for Nugget. 4. Bank service charges of $18 are not yet recorded on Nugget s books. 5. The bank returned one of Nugget s customer s checks for $220 with the bank statement, marked NSF. The bank deducted $220 from Nugget s account. 6. Nugget discovered that it incorrectly recorded check #7322, written in November for $131 in payment of an account payable, as $ A check for Nugent Oil Co. in the amount of $175 that the bank incorrectly charged to Nugget accompanied the statement LO 10

113 RECONCILIATION OF BANK BALANCES ILLUSTRATION 7A-2 Sample Bank Reconciliation LO 10

114 RECONCILIATION OF BANK BALANCES Journalize the required adjusting entries at November 30. Cash 600 Interest Revenue 600 (To record interest on Sequoia Co. bonds, collected by bank) Cash 180 Accounts Payable 180 (To correct error in recording amount of check #7322) Office Expense (bank charges) 18 Cash 18 (To record bank service charges for November) Accounts Receivable 220 Cash 220 (To record customer s check returned NSF) LO 10

115 RECONCILIATION OF BANK BALANCES Question The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks. b. deposit in transit. c. a bank error. d. bank service charges LO 10

116 APPENDIX 7B IMPAIRMENTS OF RECEIVABLES Companies assess their receivables for impairment each reporting period. Examples of possible loss events are: Significant financial problems of the customer. Payment defaults. Renegotiation of terms of the receivable. In this appendix, we discuss impairments based on the individual assessment approach for long-term receivables LO 11 Describe the accounting for a loan impairment.

117 IMPAIREMENT MEASUREMENT AND REPORTING Impairment loss is calculated as the difference between: the carrying amount (generally the principal plus accrued interest) and the expected future cash flows discounted at the loan s historical effective-interest rate. In estimating future cash flows, the creditor should use reasonable and supportable assumptions and projections LO 11

118 Impairment Loss Example Illustration: At December 31, 2014, Ogden Bank recorded an investment of 100,000 in a loan to Carl King. The loan has an historical effective-interest rate of 10 percent, the principal is due in full at maturity in three years, and interest is due annually. The loan officer performs a review of the loan s expected future cash flow and utilizes the present value method for measuring the required impairment loss ILLUSTRATION 7B-1 Impaired Loan Cash Flows LO 11

119 Recording Impairment Losses Illustration: Computation of Impairment Loss ILLUSTRATION 7B-2 Computation of Impairment Loss Journal entry to record the loss Bad Debt Expense 12,434 Allowance for Doubtful Accounts 12, LO 11

120 Recovery of Impairment Loss Illustration: Assume that in the year following the impairment recorded by Ogden, Carl King has worked his way out of financial difficulty. Ogden now expects to receive all payments on the loan according to the original loan terms. Based on this new information, the present value of the expected payments is 100,000. Thus, Ogden makes the following entry to reverse the previously recorded impairment. Allowance for Doubtful Accounts 12,434 Bad Debt Expense 12, LO 11

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